Guaranteed Partners

[Snaggletooth]

I have a partnership client which has been in operation since 1955. The partners maintain and rent a building to the U S Post Office. The town is small but is a county seat, thus unlikely that the P.O. will shut down anytime soon.

Only two of the original partners is still alive, and the partnership now has 6 members from three different generations. Only one of the existing partners operates the building maintenance and funds. The rest are inactive, passive, silent, or whatever definition you wish to place on them.

One family member suffered several years through old age and one of the partners actually nursed and was a caretaker for her. To reward this partner, the other partners decided to give her 25% share of proceeds calculated BEFORE any of the other partners got their share. The arrangement was to persist through her lifetime.

Most of us recognize this arrangement as a guaranteed payment, and her K-1 reflects this as being so. It's hard to defeat the argument that a guaranteed payment is self-employment income. However, this partner today is 88 years old, in a nursing home, and the proverbial vegetable, barely recognizing her family.

Should this person be paying self-employment tax??

[Gretel]

I don't think this is considered guaranteed payment. Part of definition of guaranteed payment: GP are usually expressed as a fixed-dollar amount or as a % of capital (not income) that the partner has invested in the partnership.

I believe this is considered a special allocation and from there I am lost.

[WhiteOleander]

Perhaps since this partner is not materially participating, she can be considered a limited partner. Then the income would be passive and not subject to SE tax. I also don't think this is a guaranteed payment.

[Snaggletooth]

Special Allocation vs Guaranteed Payment

I'm still leaning toward guaranteed payment. Special allocation, as I understand it, is recognition for non-cash contributions. Guaranteed payments are compensation arrangements measured by work that is performed.

Were this work still ongoing (instead of something arranged 30 years ago), I think there would be little doubt this would be considered a guaranteed payment. However, if there is a specific question posed by this post, it might be:

"Should a guaranteed payment bear self-employment tax if the work is no longer being done and the partner is now an inactive limited partner?"

[Gretel]

I am not sure this is the only relevant question. If his partnership interest would have been converted to a limited partnership interest without special arrangements I tend to agree that this is not subject to SE.

However, the origination of the special arrangement could be viewed as coming from being an active partner.

I know this doesn't apply to your case but there a special rules for payments to a retiring partner, some are subject to SE and others are not. Maybe there is something in there that makes sense in your scenario.